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Key Takeaways From Delaware’s Unclaimed Property Overhaul

A bill has been introduced in the Delaware Senate that would overhaul Delaware’s unclaimed property law. The bill is on a fast track and could be enacted by the end of January. If enacted, companies currently under audit will have a limited window in which to make some key decisions.

After much speculation about an anticipated response by Delaware to the Temple-Inland decision [1], a bill has been introduced in the Delaware Senate that would overhaul Delaware’s unclaimed property law. Senate Bill 13 would rewrite Delaware’s abandoned and unclaimed property law, using the recently completed Revised Uniform Unclaimed Property Act of 2016 as a baseline. The bill is on a fast track and could be enacted by the end of January.

The proposed amendments are sweeping and, in many cases, the legislation enshrines in statute, existing audit practices that have spurred much litigation by holders against Delaware. This alert addresses the significant time-sensitive issues contained in the Bill. Additional alerts in the future will address other significant changes.

10-Year Look-back

The bill provides for a 10-year look-back applicable to both audits and the Voluntary Disclosure Agreement (VDA) program. Delaware’s current unclaimed property statute is silent on the look-back period for audits for non-filers, but provides a look-back period for VDAs. Under the bill, the look-back for audits would be 10 report years from the date of the audit notice. The bill similarly proposes to increase the current three-year statute of limitations to 10 years from the date when the property became reportable. The statute of limitations for a report year is tolled once a holder has been provided with notices of an audit.

A 10-year document-retention period is also proposed. Current Delaware law has no document-retention requirement. We understand that regulations will be promulgated to provide more detailed guidance on the types of documents to be retained, but the statute requires that holders retain: (1) the verifiable information required to be included in the report; (2) the date, place, and nature of the circumstances that gave rise to the property right; (3) the amount or value of the property; (4) the last address of the owner, if known to the holder.

Provisions Impacting Audits

The legislation grants holders under audit as of July 22, 2015, the opportunity to transfer report years under audit to the state’s unclaimed property VDA program administered by the law firm of Drinker Biddle on behalf of the Secretary of State. Transfer to the VDA program, however, is not available for any securities examinations in which estimation is not required. Some pros and cons of the VDA program are discussed in more detail below. Holders wishing to transfer report years from audit to the VDA program must elect to do so by July 1, 2017.

The bill expressly authorizes the State Escheator to issue a subpoena duces tecum (a legal demand for documents) to holders in the course of an audit. Such authorization resolves an issue in the pending Blackhawk litigation [2]. Further, the bill provides the State Escheator the authority to enforce such subpoenas. As a consequence, holders who challenge the validity of auditor requests for information will have the opportunity to challenge subpoenas and present arguments against production to a Chancellor in the event the State Escheator seeks to enforce a subpoena in court. Holders with concerns about data security can present those arguments to the court and hopefully obtain protections governing the disclosure of sensitive information and/or information protected from disclosure by other statutes. Whether the state will issue subpoenas for documents that holders currently will resist producing, and whether holders should comply with such specific document requests from third-party auditors in the absence of a subpoena, are questions holders likely will face.

Under the Bill, holders under audit will have the option of choosing a newly created two-year fast track audit option. A holder currently under audit may take advantage of this option by providing written notification to the State Escheator by July 1, 2017. After notice is provided, the audit is required to be completed within two years from the date of notice. Interest and penalties will be waived. Holders choosing this option are required to respond to all audit requests for records within 18 months of providing notice.

Third-party auditors will still be authorized to conduct audits. Holders will be subject to interest, up to 50% of the unclaimed property liability, although interest assessed will be subject to waiver under certain conditions at the discretion of the state.

In addition, under the Bill, the state is still required to use a “reasonable” estimation to assess liabilities for periods for which records no longer are available. We understand that the estimation method to be applied will continue to be the method that the court in Temple-Inland found was “misleading,” and based on a “troubling” interpretation of the priority rules in Texas v. New Jersey.

As a consequence, holders may still have to challenge any estimated liability based on the methodology used in Temple-Inland. For holders that have been undergoing an audit for some years, the opportunity may exist to challenge such an assessment in federal court without the need to exhaust administrative remedies. Many of the same arguments presented in Temple-Inland likely will continue to apply to such holders. Other holders may have to exhaust administrative remedies, depending on the circumstances, before filing suit in state or federal court.

The legislation requires the Secretary of Finance, in consultation with the Secretary of State, to promulgate regulations on or before July 1, 2017, regarding the method of estimation the state may use in both VDAs and audits. The content of these regulations will be a key factor in whether holders make the conversion election afforded by the legislation, as they are to address permissible base periods, items to be excluded from estimation, aging criteria for outstanding and voided checks, and the definition of what complete and researchable records are. Holders and their representatives must stay alert to developments regarding the regulations.

Provisions Impacting the VDA Program

For holders participating in the state’s VDA program, interest and penalties will continue to be waived. While participants in the VDA program will continue working with Drinker Biddle, they will be required, under the Bill, to provide more extensive documentation than is currently mandated. The Secretary of State does not make any changes to the estimation methods required in the VDA program under the current Bill. Thus, any holder considering the move from an audit to a VDA, must consider the effects of waiving its rights to contest the estimation methodology after the Temple-Inland case.

Conclusion

Companies currently under audit will have to decide between now and July 1, 2017, regarding whether to transfer report years from audit to the VDA program or to opt into the fast-track two-year. In addition, companies should consider the advisability of attempting to enter into a settlement with the state, rather than transferring to the VDA program or continuing with an audit, depending on how far along the company is in the audit process. Thus holders must consider the tradeoff between (1) converting to a review under the state’s VDA program and agreeing to be subject to the estimation methodology found unconstitutional in Temple-Inland, but avoiding an interest assessment, or (2) continuing with an audit, thereby potentially being assessed interest, but preserving the right to challenge the estimation methodology employed to calculate an assessment. These factors will vary based on each company’s discrete set of facts, so we encourage you to consult with legal counsel.

Whether holders will benefit from a shortened look-back period is questionable in any given case, because Delaware does not appear inclined to abandon its use of the estimation methodology that the Temple-Inland decision found to be deficient and unlawful. It appears that by allowing companies currently under audit to convert to a review under the state’s VDA program, the state is hoping to avoid further legal challenges to its estimation methodology similar to those raised in the Temple-Inland case. At the same time, the Bill would make small changes to the law to bolster the state’s position on certain constitutional questions should such challenges nevertheless arise. For example, if the Bill were enacted, companies coming under audit for the first time under the new statute would be unable to claim they had no notice concerning the state’s audit methodologies, which are made explicit in the Bill.

But for those companies currently undergoing Delaware unclaimed property audits or participating in Delaware’s unclaimed property VDA program, it remains to be seen just how willing Delaware will be to limit the use of an estimation methodology that the United States District Court for the District of Delaware has stated “shocks the conscience.”

We will provide updates on this Bill as it progresses through the legislative process.

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